Fear Gauges Rising Again

By William Kemble-Diaz

The weekend is almost upon us, and the outlook for the euro-zone remains as clear as mud. What to do? Load up on insurance, just in case.

That at least, is the message from the currencies derivatives market this morning.

So-called implied volatilities—a measure of how violently investors think exchange-rates are likely to shake in future—are surging across a board of currency combinations as investors brace for more uncertainty and turbulence.

That means currency options—a widely used derivative instrument that give holders the right to buy or sell a currency at a predefined price at a predefined date—are getting more expensive again, having come off at the start of December after global central banks pumped liquidity into the financial system and as investors dared hope the EU summit might deliver.

OK, here comes the science: For the euro’s exchange rate against the dollar, one-week implied volatility is at its highest levels in a month, at just over 17%. In broad terms, that means currency option prices imply an expected daily movement in the pair over the next week of around 1.40 cents. Pretty choppy stuff.

In the case of the euro, investors are also loading up more on negative (put) options than positive (call) options, another sign that bearish sentiment is on the up once more as prospects for the single currency deteriorate.

It’s not quite panic stations yet. On the spot market, the euro is depressed, but hardly in freefall, holding steady at $1.3330 or so. But traders’ nerves are getting frayed yet again.